Inflation’s Impact: How Canada’s 4.4% Rise Could Shake the Housing Market?

On 16 May 2023, Statistics Canada reported that The Consumer Price Index (CPI) rose by 4.4% year over year in April, which was a straight-up 0.7% increase (month over month) compared to March of 2023. As per the report, rising mortgage costs and higher rental costs were the driving factors behind this inflation surge. Mortgage payments went up by 28.5% in April 2023 compared to April 2022, as more people took out new mortgages or renewed existing ones at higher interest rates. At the same time, rental charges increased by 6.1% in April 2023 due to high demand.

Another interesting factor at play is Replacement Cost, i.e., the cost of replacing an existing asset with a similar asset at the current market price. The index measuring the cost of replacing a homeowner's property showed a small growth of 0.2% in April, which suggests a slowdown in the housing market after a 1.7% increase in March. Combine this with the challenges faced in the supply chain affecting new home construction, which has collectively led to higher housing costs in Ontario and across Canada. This unforeseen development took experts and observers by surprise, highlighting the significant impact it could have on the economy and Canadian real estate by extension.

Mortgage interest costs and homeowners’ replacement costs since Jan 2020

Source: Statistics Canada

Rental costs over the years

Source: Statistics Canada

Is The Policy Rate Going to Increase On June 7th?

According to the Bank of Canada (BoC), mortgage payments for many borrowers will increase by 20% to 40% when they renew their loans in the coming years (Most mortgage contracts will be up for renewal in 2025 and 2026.). Around one-third of mortgages in Canada have already seen an increase in repayments since the central bank started raising its benchmark interest rate. Borrowers who are on a variable rate mortgage are the ones facing the brunt of the current rate hikes, even though their monthly payments have remained unchanged. This is because a large amount of their payments is now going towards the interest of the mortgage rather than the principal amount, which has extended their loan repayment period beyond 30 years in the process. When borrowers renew their loans without refinancing, they will have to return to the original repayment schedule, which is why the BoC estimates that their payments will need to increase by 40% if they stick to it. BoC believes that most households can handle the higher mortgage payments, considering the strong job market and low unemployment. Still, there will be cases where some households may be more affected than others.

The higher interest rates have led to increased demand for rentals, pushing up prices. Two measures of underlying inflation, CPI-median (price change at the middle of the price distribution.) and CPI-trim (a measure that excludes both the highest and lowest price changes in each category), averaged at 4.2% in April 2023, 0.3% lower than that in March. According to many experts, BoC still has wiggle room when it comes to keeping the policy rate steady, and thus, they believe their target inflation rate of 3% in 2023 and 2% in 2024 is still achievable. But the recent surge in both the real estate market and inflation rate poses unwelcoming challenges for the BoC. Home prices have experienced increases in the last few months, with the benchmark price rising by approximately $15,000 and the average home price increasing by $30,000 in April. The combination of steady interest rates and stabilising prices prompted buyers to enter the market. However, the unexpected acceleration in inflation, the first in Canada in the past 10 months, may force the BoC to reconsider its interest rate strategy, contrary to its desired direction. But if the interest rate goes up, people will not be able to keep pace, and they will soon start defaulting, which can create a larger economic crisis.

The Canadian property market is currently uncertain, and BoC has issued warnings about potential vulnerabilities in the international financial system that could impact Canadian institutions. BoC has already highlighted the risks of defaults in the small business and commercial real estate sectors. In light of these circumstances, it is highly probable that the Bank of Canada will maintain the current interest rates on June 7 and keep them stable in the foreseeable future. Like you, we are all eagerly waiting for the next announcement. Till then, hold tight, and stay positive!